To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 15 Equity ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Brief Exercises Exercises Problems Concepts for Analysis Shareholders’ rights; corporate form 1, 2, Equity 4, 5, 6, 16, 17, 18, 29, 30, 31 7, 10, 16, 17 1, 2, 3, Issuance of shares 7, 10 1, 2, 1, 2, 4, 6, 1, 3, 4 Noncash share transactions; lump sum sales 8, 4, 3, 4, 5, 1, Treasury share transactions, cost method 11, 12, 17 7, 3, 6, 7, 9, 10, 18 1, 2, 3, 5, 6, 7 Preference stock 3, 13, 14, 15 2, 1, 10, 11, 16, 17 9, 11, 12 Equity accounts; classifications; terminology Dividend policy 19, 20, 21, 22, 25, 26 10 12, 15 7, 10 Cash and share dividends; share splits; property dividends; liquidating dividends 22, 23, 24 10, 11, 12, 13, 14 13, 14, 15, 18 6, 7, 8, 10, 11 10 Restrictions of retained earnings 27, 28 17, 19, 20 32 4, 5, 11 Presentation and analysis *12 Dividend preferences and book value 15 12 21, 22, 23, 24 *This material is covered in an Appendix to the chapter Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-1 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Brief Exercises Learning Objectives Exercises Problems Discuss the characteristics of the corporate form of organization Identify the key components of equity Explain the accounting procedures for issuing shares 1, 2, 4, 5, 1, 2, 3, 4, 5, 6, 8, 9, 10 1, 3, 4, 9, 12 Describe the accounting for treasury shares 3, 7, 6, 7, 9, 10, 18 1, 2, 3, 5, 6, 7, 9, 12 Explain the accounting for and reporting of preference shares 5, Describe the policies used in distributing dividends 10, 11, 12 16 Identify the various forms of dividend distributions 11, 12 11, 12, 15, 16, 18 3, 6, 7, 8, 9, 11, 12 Explain the accounting for small and large share dividends, and for share splits 13, 14 11, 13, 14, 15, 16, 18 3, 8, 10, 11, 12 Indicate how to present and analyze equity 17, 19, 20 1, 2, 6, 9, 11, 12 Explain the different types of preference share dividends and their effect on book value per share 15 8, 21, 22, 23, 24 *10 15-2 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ASSIGNMENT CHARACTERISTICS TABLE Item Description Level of Difficulty Time (minutes) E15-1 E15-2 E15-3 E15-4 E15-5 E15-6 E15-7 E15-8 E15-9 E15-10 E15-11 E15-12 E15-13 E15-14 E15-15 E15-16 E15-17 E15-18 E15-19 E15-20 *E15-21 *E15-22 *E15-23 *E15-24 Recording the issuances of ordinary shares Recording the issuance of ordinary and preference shares Shares issued for land Lump-sum sale of shares with bonds Lump-sum sales of ordinary and preference shares Share issuances and repurchase Effect of treasury share transactions on financials Preference share entries and dividends Correcting entries for equity transactions Analysis of equity data and equity section preparation Equity items on the statement of financial position Cash dividend and liquidating dividend Share split and share dividend Entries for share dividends and share splits Dividend entries Computation of retained earnings Equity section Dividends and equity section Comparison of alternative forms of financing Trading on the equity analysis Preference dividends Preference dividends Preference share dividends Computation of book value per share Simple Simple Simple Moderate Simple Moderate Moderate Moderate Moderate Moderate Simple Simple Simple Simple Simple Simple Moderate Moderate Moderate Moderate Simple Moderate Complex Moderate 15–20 15–20 10–15 20–25 10–15 25–30 15–20 15–20 15–20 20–25 15–20 10–15 10–15 10–12 10–15 05–10 20–25 30–35 20–25 15–20 10–15 15–20 15–20 10–20 P15-1 P15-2 P15-3 P15-4 P15-5 P15-6 P15-7 P15-8 P15-9 P15-10 P15-11 P15-12 Equity transactions and statement preparation Treasury share transactions and presentation Equity transactions and statement preparation Share transactions—lump sum Treasury shares—cost method Treasury shares—cost method—equity section preparation Cash dividend entries Dividends and splits Equity section of statement of financial position Share dividends and share split Share and cash dividends Analysis and classification of equity transactions Moderate Simple Moderate Moderate Moderate Moderate Moderate Moderate Simple Moderate Simple Complex 50–60 25–35 25–30 20–30 30–40 30–40 15–20 20–25 20–25 35–45 25–35 35–45 CA15-1 CA15-2 CA15-3 CA15-4 CA15-5 CA15-6 CA15-7 Preemptive rights and dilution of ownership Issuance of shares for land Conceptual issues—equity Share dividends and splits Share dividends Share dividend, cash dividend, and treasury shares Treasury shares, ethics Moderate Moderate Moderate Simple Simple Moderate Moderate 10–20 15–20 25–30 25–30 15–20 20–25 10–15 *This material is presented in an appendix to the chapter Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-3 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ANSWERS TO QUESTIONS The basic rights of each shareholder (unless otherwise restricted) are to share proportionately: (1) in profits, (2) in management (the right to vote for directors), (3) in corporate assets upon liquidation, and (4) in any new issues of shares of the same class (preemptive right) The preemptive right protects existing shareholders from dilution of their ownership share in the event the corporation issues new shares Preference shares commonly have preference to dividends in the form of a fixed dividend rate and a preference over ordinary shares to remaining corporate assets in the event of liquidation Preference shares usually not give the holder the right to share in the management of the company Ordinary shares are the residual security possessing the greater risk of loss and the greater potential for gain; they are guaranteed neither dividends nor assets upon dissolution but they generally control the management The distinction between contributed (paid-in) capital and retained earnings is important for both legal and economic points of view Legally, dividends can be declared out of retained earnings in all countries, but in many countries dividends cannot be declared out of contributed (paid-in) capital Economically, management, shareholders, and others look to earnings for the continued existence and growth of the corporation Authorized ordinary shares—the total number of shares authorized by the country of incorporation for issuance Unissued ordinary shares—the total number of shares authorized but not issued Issued ordinary shares—the total number of shares issued (distributed to shareholders) Outstanding ordinary shares—the total number of shares issued and still in the hands of shareholders (issued less treasury shares) Treasury shares—shares issued and repurchased by the issuing corporation but not retired Par value is an arbitrary, fixed per share amount assigned to a share by the incorporators It is recognized as the amount that must be paid in for each share if the shares are to be fully paid when issued If not fully paid, the shareholder has a contingent liability for the discount results The issuance for cash of no-par value ordinary shares at a price in excess of the stated value of the ordinary shares is accounted for as follows: (1) Cash is debited for the proceeds from the issuance of the ordinary shares (2) Share Capital—Ordinary is credited for the stated value of the ordinary shares (3) Share Premium—Ordinary is credited for the excess of the proceeds from the issuance of the ordinary shares over their stated value The proportional method is used to allocate the lump sum received on sales of two or more classes of securities when the fair value or other sound basis for determining relative value is available for each class of security In instances where the fair value of all classes of securities is not determinable in a lump-sum sale, the incremental method must be used The value of the securities is used for those classes that are known and the remainder is allocated to the class for which the value is not known 15-4 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 15 (Continued) The general rule to be applied when shares are issued for services or property other than cash is that companies should record the shares issued at the fair value of the goods or services received, unless that fair value cannot be measured reliably If the fair value of the goods or services cannot be measured reliably, use the fair value of the shares issued If a company cannot readily determine either the fair value of the shares it issues or the property or services it receives, it should employ an appropriate valuation technique Depending on available data, the valuation may be based on market transactions involving comparable assets or the use of discounted expected future cash flows Companies should avoid the use of the book, par, or stated values as a basis of valuation for these transactions 10 The direct costs of issuing shares, such as underwriting costs, accounting and legal fees, printing costs, and taxes, should be reported as a reduction of the amounts paid in Issue costs are therefore debited to Share Premium because they are unrelated to corporate operations 11 The major reasons for purchasing its own shares are: (1) to provide tax-efficient distributions of excess cash to shareholders, (2) to increase earnings per share and return on equity, (3) to provide shares for employee compensation contracts, (4) to thwart takeover attempts or to reduce the number of shareholders, (5) to make a market in the company’s shares 12 (a) Treasury shares should not be classified as an asset since a corporation cannot own itself (b) The ―gain‖ or ―loss‖ on sale of treasury shares should not be treated as additions to or deductions from income If treasury shares are carried in the accounts at cost, these socalled gains or losses arise when the treasury shares are sold These ―gains‖ or ―losses‖ should be considered as additions to or reductions of equity In some instances, the ―loss‖ should be charged to Retained Earnings ―Gains‖ or ―losses‖ arising from treasury shares transactions are not included as a component of net income since dealings in treasury shares represent equity transactions (c) Dividends on treasury shares should never be included as income, but should be credited directly to retained earnings, against which they were incorrectly charged Since treasury shares cannot be considered an asset, dividends on treasury shares are not properly included in net income 13 The character of preference shares can be altered by being cumulative or non-cumulative, participating or non-participating, convertible or non-convertible, and/or callable or non-callable 14 Nonparticipating means the security holder is entitled to no more than the specified fixed dividend If the security is partially participating, it means that in addition to the specified fixed dividend the security may participate with the ordinary shares in dividends up to a certain stated rate or amount A fully participating security shares pro rata with the ordinary shares dividends declared without limitation In this case, Kim Inc has fully participating preference shares Cumulative means dividends not paid in any year must be made up in a later year before any profits can be distributed to ordinary shareholders Any dividends not paid on cumulative preference shares constitute a dividend in arrears A dividend in arrears is not a liability until the board of directors declares a dividend 15 Preference shares are generally reported at par value as the first item in the equity section of a company’s statement of financial position Any excess over par value is reported as share premium-preference 16 Sources of equity include (1) share capital, (2) share premium, (3) retained earnings, (4) accumulated other comprehensive income, and reduced by (5) treasury shares Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-5 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 15 (Continued) 17 When treasury shares are purchased, the Treasury Shares account is debited and Cash is credited at cost (€290,000 in this case) Treasury Shares is a contra equity account and Cash is an asset Thus, this transaction has: (a) no effect on net income, (b) decreases total assets, (c) has no effect on retained earnings, and (d) decreases total equity 18 The answers are summarized in the table below: Account (a) Share capital—ordinary (b) Retained Earnings (c) Share Premium—Ordinary (d) Treasury Shares (e) Share Premium—Treasury (f) Accumulated Other Comprehensive Income (g) Share capital—preference Classification Share capital Retained earnings Share premium Deducted from total equity Share premium Added to total equity Share capital 19 The dividend policy of a company is influenced by (1) the availability of cash, (2) the stability of earnings, (3) current earnings, (4) prospective earnings, (5) the existence or absence of contractual restrictions on working capital or retained earnings, and (6) a retained earnings balance 20 In declaring a dividend, the board of directors must consider the condition of the corporation such that a dividend is (1) legally permissible and (2) economically sound In general, directors should give consideration to the following factors in determining the legality of a dividend declaration: (1) Retained earnings, unless legally encumbered in some manner, is usually the correct basis for dividend distribution (2) Dividends in some jurisdictions may not reduce retained earnings below the cost of treasury shares held In addition, in some jurisdictions, share premium may be used for dividends, although such dividends may be limited to preference shares Generally, deficits in retained earnings and debits in contributed (paid-in) capital accounts must be restored before payment of any dividends In order that dividends be economically sound, the board of directors should consider: (1) the availability (liquidity) of assets for distribution; (2) agreements with creditors; (3) the effect of a dividend on investor perceptions (e.g maintaining an expected ―pay-out ratio‖); and (4) the size of the dividend with respect to the possibility of paying dividends in future bad years In addition, the ability to expand or replace existing facilities should be considered 21 Cash dividends are paid out of cash A balance must exist in retained earnings to permit a legal distribution of profits, but having a balance in retained earnings does not ensure the ability to pay a dividend if the cash situation does not permit it 22 A cash dividend is a distribution in cash while a property dividend is a distribution in assets other than cash Any dividend not based on retained earnings is a liquidating dividend A share dividend is the issuance of additional shares in a nonreciprocal exchange involving existing shareholders with no change in the par or stated value 23 A share dividend results in the transfer from retained earnings to share capital and share premium of an amount equal to the market value of each share (if the dividend is less than 20– 25%) or the par value of each share (if the dividend is greater than 20–25%) No formal journal entries are required for a share split, but a notation in the ledger accounts would be appropriate to show that the par value of the shares has changed 15-6 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 15 (Continued) 24 (a) A share split effected in the form of a dividend is a distribution of corporate shares to present shareholders in proportion to each shareholder’s current holdings and can be expected to cause a material decrease in the market value per share IFRS specifies that a distribution in excess of 20% to 25% of the number of shares previously outstanding would cause a material decrease in the market value This is a characteristic of a share split as opposed to a share dividend, but, for legal reasons, the term ―dividend‖ must be used for this distribution From an accounting viewpoint, it should be disclosed as a share split effected in the form of a dividend because it meets the accounting definition of a share split as explained above (b) The share split effected in the form of a dividend differs from an ordinary share dividend in the amount of retained earnings to be capitalized An ordinary share dividend involves capitalizing (charging) retained earnings equal to the fair value of the shares distributed A share split effected in the form of a dividend involves charging retained earnings for the par (stated) value of the additional shares issued Another distinction between a share dividend and a share split is that a share dividend usually involves distributing additional shares of the same class with the same par or stated value A share split usually involves distributing additional shares of the same class but with a proportionate reduction in par or stated value The aggregate par or stated value would then be the same before and after the share split (c) A declared but unissued share dividend should be classified as part of equity rather than as a liability in a statement of financial position A share dividend affects only equity accounts; that is, retained earnings is decreased and share capital and share premium are increased Thus, there is no debt to be paid, and, consequently, there is no severance of corporate assets when a share dividend is issued Furthermore, share dividends declared can be revoked by a corporation’s board of directors any time prior to issuance Finally, the corporation usually will formally announce its intent to issue a specific number of additional shares, and these shares must be reserved for this purpose 25 A partially liquidating dividend will be debited both to Retained Earnings and Share Premium The portion of dividends that is a return of capital should be debited to Share Premium 26 A property dividend is a nonreciprocal transfer of nonmonetary assets between an enterprise and its owners A transfer of a nonmonetary asset to a shareholder or to another entity in a nonreciprocal transfer should be recorded at the fair value of the asset transferred, and a gain or loss should be recognized on the disposition of the asset 27 Retained earnings are restricted because of legal or contractual restrictions, or the necessity to protect the working capital position 28 Restrictions of retained earnings are best disclosed in a note to the financial statements This allows a more complete explanation of the restriction 29 No, Mary should not make that conclusion While IFRS allows unrealized losses on non-trading equity investments to be reported under ―Reserves‖, U.S GAAP requires these losses to be reported as other comprehensive income Specifically, unrealized losses are reported in the Accumulated Other Comprehensive Income (Loss) account under U.S GAAP 30 Key similarities between IFRS and U.S GAAP for transactions related to equity pertain to (1) issuance of shares, (2) purchase of treasury shares, (3) declaration and payment of dividends, (4), the costs associated with issuing shares reduce the proceeds from the issuance and reduce contributed (paid-in) capital, and (5) the accounting for par, no par and no par shares with a stated value Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 15 (Continued) Major differences relate to terminology used, introduction of items such as revaluation surplus, and presentation of stockholder equity information In addition, the accounting for treasury stock retirements differs between IFRS and U.S GAAP Under U.S GAAP a company has the option of charging the excess of the cost of treasury stock over par value to (1) retained earnings, (2) allocate the difference between paid in capital and retained earnings, or (3) charge the entire amount to paid-in capital Under IFRS, the excess may have to be charged to paid-in capital, depending on the original transaction related to the issuance of the stock An IFRS/U.S GAAP difference relates to the account Revaluation Surplus Revaluation surplus arises under IFRS because of increases or decreases in property, plant and equipment, mineral resources, and intangible assets This account is part of general reserves under IFRS and is not considered contributed capital 31 It is likely that the statement of stockholders’ equity and its presentation will be examined closely in the financial statement presentation project In addition the options of how to present other comprehensive income under U.S GAAP will change in any converged standard in this area *32 (a) Preference $ 7,000 9,000 $16,000 Current year’s dividend, 7% Participating dividend of 9% Totals Ordinary $21,000a 27,000 $48,000 Total $28,000 36,000 $64,000 a (see schedule below for computation of amounts) The participating dividend was determined as follows: Current year’s dividend: Preference, 7% of $100,000 = $ 7,000 Ordinary, 7% of $300,000 = 21,000 $28,000 Amount available for participation ($64,000 – $28,000) $36,000 Par value of stock that is to participate ($100,000 + $300,000) $400,000 Rate of participation ($36,000 ÷ $400,000) Participating dividend: Preference, 9% of $100,000 Ordinary, 9% of $300,000 Dividends 15-8 Copyright © 2011 John Wiley & Sons, Inc 9% $ 9,000 27,000 $36,000 Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Questions Chapter 15 (Continued) (b) Dividends in arrears, 7% of $100,000 Current year’s dividend, 7% Participating dividend 7.25% ($29,000 ÷ $400,000)* Totals Preference $ 7,000 7,000 7,250 $21,250 Ordinary $21,000 21,750 $42,750 Total $ 7,000 28,000 29,000 $64,000 Preference Ordinary $2,000 7,000 $21,000 $9,000 $21,000 Total $ 2,000 7,000 21,000 $30,000 *(The same type of schedule as shown in (a) could be used here) (c) Dividends in arrears ($100,000 X 7%) – $5,000 Current year’s dividend, 7% Remainder to common Totals Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-9 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 15-1 Cash Share Capital—Ordinary (300 X €10) Share Premium—Ordinary 4,500 3,000 1,500 BRIEF EXERCISE 15-2 (a) Cash Share Capital—Ordinary 8,200 (b) Cash Share Capital—Ordinary (600 X €2) Share Premium—Ordinary 8,200 8,200 1,200 7,000 BRIEF EXERCISE 15-3 WILCO CORPORATION Equity December 31, 2010 Share Capital—Ordinary, €5 par value Share Premium—Ordinary Retained earnings Less: Treasury shares Total equity € 510,000 1,320,000 2,340,000 (90,000) €4,080,000 BRIEF EXERCISE 15-4 Cash Share Capital—Preference (100 X $50) Share Premium—Preference Share Capital—Ordinary (300 X $10) Share Premium—Ordinary 13,500 FV of ordinary (300 X $20) FV of preference (100 X $90) Total FV $ 6,000 9,000 $15,000 15-10 Copyright © 2011 John Wiley & Sons, Inc 5,000 3,100 3,000 2,400 Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS CA 15-1 (Time 10–20 minutes) Purpose—to provide the student with some familiarity with the applications of the ordinary share system This case requires the student to analyze the concept dealing with the dilution of ownership interest and the establishment of any necessary corrective actions to compensate an existing shareholder for this dilution effect CA 15-2 (Time 15–20 minutes) Purpose—to provide the student with an opportunity to discuss the bases for recording the issuance of shares in exchange for non-monetary assets CA 15-3 (Time 25–30 minutes) Purpose—to provide a five-part theory case on equity based on the IASB conceptual framework It requires defining terms and analyzing the effects of equity transactions on financial statement elements CA 15-4 (Time 25–30 minutes) Purpose—to provide the student with an understanding of the conceptual framework which underlies a share dividend and a share split The student is required to explain what a share dividend is, the amount of retained earnings to be capitalized in connection with a share dividend, and how it differs from a share split both from a legal standpoint and an accounting standpoint This case also requires an explanation of the various reasons why a corporation declares a share dividend or a share split CA 15-5 (Time 15–20 minutes) Purpose—to provide the student with an understanding of the theoretical concepts and implications that underlie the issuance of a share dividend The student is required to discuss the arguments against either considering the share dividend as income to the recipient or issuing share dividends on treasury shares CA 15-6 (Time 20–25 minutes) Purpose—to provide the student with a situation containing a cash dividend declaration, a share dividend, and a reacquisition and reissuance of shares requiring the student to explain the accounting treatment CA 15-7 (Time 10–15 minutes) Purpose—to provide an opportunity for the student to consider and discuss the ethical issues involved when the control of a corporation is at stake The student should recognize the potential conflict between the CEO’s personal will and the responsibility and accountability the CEO has to the shareholders 15-64 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com SOLUTIONS TO CONCEPTS FOR ANALYSIS CA 15-1 (a) To share proportionately in any new issues of shares of the same class (the preemptive right) (b) Derek Wallace bought an additional $100,000 par value shares His original ownership was $200,000 ($250,000 X 80%) Thus he increased his ownership by 100/200 (50%) This imbalance can be corrected by issuing to Ms Baker, at par, shares equal to 50% of her present holdings of $25,000 or shares with a par value of $12,500 Other shareholders should also be offered the right to purchase shares equal to 50% of their holdings in order that all shareholders may retain the same proportionate interest as before the issuance of additional shares (c) No information is given with respect to the fair value of the shares In this situation, an estimate for fair value could be developed based on market transactions involving comparable assets Otherwise, discounted expected cash flows could be used to approximate fair value In this closely held company, and in the absence of reliable fair value data, the book value might be used for the computation of the amount of the cash settlement Book value of Ms Baker’s ordinary shares, June 30, 2010, before issuance of additional shares, 25/250 X $422,000 Book value after issuance of additional shares to Derek Wallace, 25/350 X $522,000 Loss in book value and amount of cash settlement $42,200 (37,286) $ 4,914 CA 15-2 (a) The general rule to be applied when shares are issued for services or property other than cash is that companies should record the shares issued at the fair value of the goods or services received, unless that fair value cannot be measured reliably If the fair value of the goods or services cannot be measured reliably, use the fair value of the shares issued If a company cannot readily determine either the fair value of the shares it issues or the property or services it receives, it should employ an appropriate valuation technique Depending on available data, the valuation may be based on market transactions involving comparable assets or the use of discounted expected future cash flows Companies should avoid the use of the book, par, or stated values as a basis of valuation for these transactions (b) If the fair value of the land can be measured reliably, it is used as a basis for recording the exchange The fair value could be determined by observing the cash sales price of similar pieces of property or through independent appraisals (c) If the fair value of the land cannot be measured reliably, but the fair value of the shares issued is determinable, the fair value of the shares is used as a basis for recording the exchange If the shares are traded on an exchange, the fair value can be determined from that day’s cash sales of the shares If the shares are traded over the counter, recent sales or bid prices can be used to estimate fair value (d) If Martin intentionally records this transaction at an amount greater than fair value, both assets and equity will be overstated This overvaluation of equity from the inflated asset value is referred to as watered shares This excess can be eliminated by writing down the overvalued assets with a corresponding charge to the appropriate equity accounts Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-65 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 15-3 (a) Equity, or net assets, is the residual interest in the assets of the entity after deducting all its liabilities; in other words, equity equals assets less liabilities Assets are resources controlled by the entity as the result of past events and from which future economic benefits are expected to flow to the entity Liabilities are present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits (b) Transactions or events that change equity include revenues and expenses, gains and losses, investments by owners, and distributions to owners (c) Generally, investments by owners cause an increase in assets in addition to the increase in equity (d) Dividends generally initially cause an increase in liabilities but eventually cause a decrease in assets in addition to the decrease in equity The purchase of treasury shares causes a decrease in assets in addition to the decrease in equity (e) Some examples of changes within equity that not change the total amount of equity are retirement of treasury shares, conversion of preference shares into ordinary shares, share dividends, and retained earnings appropriations CA 15-4 (a) A share dividend is the issuance by a corporation of its own shares to its shareholders on a prorata basis without receiving payment therefor The share dividend results in an increase in the amount of the legal or share capital and share premium of the enterprise The dividend may be charged to retained earnings or to any other equity account that is not a part of legal capital (1) From the legal standpoint a share split is distinguished from a share dividend in that a split results in an increase in the number of shares outstanding and a corresponding decrease in the par or stated value per share A share dividend, though it results in an increase in the number of shares outstanding, does not result in a decrease in the par or stated value of the shares (2) The major distinction is that a share dividend requires a journal entry to decrease retained earnings and increase paid-in capital, while there is no entry for a share split Also, from the accounting standpoint the distinction between a share dividend and a share split is dependent upon the intent of the board of directors in making the declaration If the intent is to give to shareholders some separate evidence of a part of their prorata interests in accumulated corporate earnings, the action results in a share dividend If the intent is to issue enough shares to reduce the market price per share, the action results in a share split, regardless of the form it may take In other words, if the action takes the form of a share dividend but reduces the market price markedly, it should be considered a share split Such reduction will seldom occur unless the number of shares issued is at least 20% to 25% of the number previously outstanding (b) The usual reason for issuing a share dividend is to give the shareholders something on a dividend date and yet conserve working capital A share dividend that is charged to retained earnings reduces the total accumulated earnings, and all share dividends reduce the per share earnings Issuing a share dividend to achieve these ends would be a public relations gesture in that the public would be less likely to criticize the corporation for high profits or undue retention of earnings 15-66 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 15-4 (Continued) A share dividend also may be issued for the purpose of obtaining a wider distribution of the shares Although this is the main consideration in a stock split, it may be a secondary consideration in the issuance of a share dividend The issuance of a series of share dividends will accomplish the same objective as a stock split A share split is intended to obtain wider distribution and improved marketability of shares by means of a reduction in the market value of the company’s shares (c) The amount of retained earnings to be capitalized in connection with a share dividend (in the accounting sense) might be (1) the legal minimum (usually par or stated value), (2) the average share capital per outstanding share, or (3) the market value of the shares The third basis is generally recommended on the grounds that recipients tend to regard the market value of the shares received as a dividend as the amount of earnings distributed to them If the corporation in such cases does not capitalize an amount equal to the fair value of the shares distributed as a dividend, there is left in the corporation’s retained earnings account an amount of earnings that the shareholders believe has been distributed to them This amount would be subject to further share dividends or to cash dividends The recipients might thus be misled into believing that the company’s distributions—and earnings—are greater than they actually are If the per share market value of the shares is materially reduced as a result of a distribution (usually 20%–25% of shares outstanding or more), no matter what form the distribution takes, the action is in substance a share split and should be so designated and treated as such CA 15-5 (a) The case against treating an ordinary share dividend as income is supported by a majority of accounting authorities It is based upon ―entity‖ and ―proprietary‖ interpretations If the corporation is considered an entity separate from shareholders, the income of the corporation is corporate income and not income to shareholders, although the equity of the shareholders in the corporation increases as income to the corporation increases This position is consistent with the interpretation that a dividend is not income to the recipient until it is realized as a result of a division, distribution, or severance of corporate assets The share dividend received merely redistributes each stockholder’s equity over a larger number of shares Selling the share dividend under this interpretation has the effect of reducing the recipient’s proportionate share of the corporation’s equity A similar position is based upon a ―proprietary‖ interpretation Income of the corporation is considered income to the owners and, hence, share dividends represent only a reclassification of equity since there is no increase in total proprietorship (b) The case against issuing share dividends on treasury shares rests principally upon the argument that shares reacquired by the corporation is a ―reduction of equity‖ through the payment of cash to reduce the number of outstanding shares According to this view, the corporation cannot obtain a proprietary interest in itself when it reacquires its own shares The retained earnings are con-sidered divisible only among the owners of outstanding shares and only the outstanding shares are entitled to a share dividend In those states that permit treasury shares to participate in the distribution accompanying a share dividend or share split, practice is influenced by the planned use of the treasury shares (such as, the issuance of treasury shares in connection with employee share options) Unless there are specific uses for the treasury shares, no useful purpose is served by issuing additional shares to treasury Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-67 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CA 15-6 (a) Mask Company should account for the purchase of the treasury shares on August 15, 2010, by debiting Treasury Shares and crediting Cash for the cost of the purchase (1,000 shares X €18 per share) Mask should account for the sale of the treasury shares on September 14, 2010, by debiting Cash for the selling price (500 shares X $20 per share), crediting Treasury Shares for cost (500 shares X €18 per share), and crediting Share Premium—Treasury for the excess of the selling price over the cost (500 shares X €2 per share) The remaining treasury shares (500 shares X €18 per share) should be presented separately in the equity section of Mask’s December 31, 2010, statement of financial position as an unallocated reduction of equity These shares are considered issued but not part of ordinary shares outstanding (b) Mask should account for the share dividend by debiting Retained Earnings for €21 per share (the market value of the shares in October 2010, the date of the share dividend) multiplied by the 1,950 shares distributed Mask should then credit Share Capital—Ordinary for the par value of the ordinary shares (€10 per share) multiplied by the 1,950 shares distributed, and credit Share Premium—Ordinary for the excess of the market value (€21 per share) over the par value (€10 per share) multiplied by the 1,950 shares distributed Total equity does not change, but, because this is considered a small share dividend, recognition has been made of capitalization of retained earnings equivalent to the market value of the additional shares resulting from the share dividend (c) Mask should account for the cash dividend on December 20, 2010, the declaration date, by debiting Retained Earnings and crediting Cash Dividends Payable for €1 per share multiplied by the number of shares outstanding 21,450 (20,000 – 1,000 + 500 + 1,950) A cash dividend is a distribution to the corporation’s shareholders The liability for this distribution is incurred on the declaration date, and it is a current liability because it is payable within one year (January 10, 2011) The effect of the cash dividend on Mask’s statement of financial position at December 31, 2010, is an increase in current liabilities and a decrease in retained earnings CA 15-7 (a) The stakeholders are the dissident shareholders, the other shareholders, potential investors, creditors, and Kenseth (b) The ethical issues are honesty, job security, and personal responsibility to others That is, by using her inside information and her authority to the buy-back, she can benefit herself at the potential expense of other stakeholders (c) It is important for Kenseth to consider what is good for the corporation, not just for her (in finance terminology, an agency issue) Kenseth should consider the following questions: (1) Are there better uses for the cash? (2) Can she possibly win over the dissidents in some other way? (3) Would this buyout be in the long-term best interest of all parties? 15-68 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com FINANCIAL REPORTING PROBLEM (a) M&S’s does not have any preference shares (b) M&S’s ordinary shares have a par value of 25p per share Like many companies, the par value of M&S’s ordinary shares is small relative to its market value (c) At 29 March, 2008, M&S had 1,586.5 million ordinary shares issued This represents 49.6 percent (3,200,000) of M&S’s authorized ordinary shares (d) At 29 March, 2008 and 31 March, 2007, M&S had 1,586.5 million and 1,699.8 million ordinary shares outstanding, respectively (e) The cash dividends caused M&S’s Retained Earnings to decrease by £343.6 million (f) Return on ordinary share equity: 2008: £821/[£1,964 + £1,648.2/2] = 45.5% 2007: £659.9/[£1,648.2 + £1,203.7/2] = 46.3% (g) Payout ratio: 2008: £343.6/£821 = 41.9% 2007: £260.6/£659.9 = 39.5% Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-69 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com COMPARATIVE ANALYSIS CASE (a) Par value: Cadbury, 10p per share Nestlé, CHF0.10 per share (b) Percentage of authorized shares issued: Cadbury, 1,352,990,574 ÷ 2,500,000,000 = 54.1% Nestlé, 3,830,000,000 ÷ 3,830,000,000 = 100% (c) Treasury shares, year-end 2008: Cadbury, 10,000,000 shares Nestlé, 214,392,760 shares (d) Ordinary shares outstanding, year-end 2008: Cadbury, 1,352,990,574 – 10,000,000 = 1,342,990,574 Nestlé, 3,830,000,000 – 214,392,760 = 3,615,607,240 (e) Cadbury declared cash dividends in 2008, reducing equity by £73,000,000 (5.3 p/share) Nestlé declared cash dividends in 2008, reducing equity by CHF4,573 million (12.2 CHF/share) (f) Rate of return on ordinary share equity 2008: Cadbury Nestlé 15-70 £366 £3,534 + £4,173 = 9.5% CHF19,051 = 34.7% CHF54,916 + CHF54,776 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com COMPARATIVE ANALYSIS CASE (Continued) 2007: Cadbury Nestlé £407 £4,173 + £3,688 = 10.4% CHF11,382 = 21.2% CHF54,776 + CHF52,848 During 2007 and 2008, Nestlé earned a significantly higher return on its ordinary share equity (g) Payout ratios for 2008 Cadbury Nestlé £73 £366 = 19.9% CHF4,573* CHF19,051 = 24.0% *Based on dividends paid Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-71 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com FINANCIAL STATEMENT ANALYSIS CASES CASE (a) Management might purchase treasury shares to provide to shareholders a tax-efficient method for receiving cash from the corporation In addition, it might have to repurchase shares to have them available to issue to people exercising options to purchase shares, or management might purchase treasury shares because it feels that its share price is too low It may believe that by purchasing shares it is signalling to the market that the price is too low Management might also use excess cash to purchase shares to ward off a hostile takeover Finally, management might purchase shares in an effort to change its capital structure If it purchases shares and issues debt (or at least does not retire debt), it will increase the percentage of debt in its capital structure (b) Earnings per share is calculated by dividing net income by the weightedaverage number of shares outstanding during the year If shares are reduced by treasury share purchases, the denominator (weighted-average number of shares outstanding) is reduced As a result, earnings per share is often increased However, because corporate assets are reduced by the purchase of the treasury shares, earnings potential may decrease If this occurs, the effect on earnings per share may be mitigated (c) One measure of solvency is the ratio of debt divided by total assets This ratio shows how many dollars of assets are backing up each dollar of debt, should the company become financially troubled For 2009 and 2008, this can be calculated as follows: 2009 2008 ($38,059 ÷ $78,770) = 48 ($36,965 ÷ $76,008) = 49 This represents a slight decrease in the ratio of debt to total assets It may be determined that BHP Billiton’s solvency is improving, but it should definitely be watched, and in comparison to industry averages 15-72 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com FINANCIAL STATEMENT ANALYSIS CASES CASE (a) The date of record marks the time when ownership of the outstanding shares is determined for dividend purposes This in turn identifies which shareholders will receive the share dividend This date is also used when a share split occurs The date of distribution is when the additional shares are distributed (issued) to shareholders (b) The purpose of a share split is to increase the marketability of the shares by lowering its market value per share This may make it easier for the corporation to issue additional shares (c) The effects are (1) no effect, (2) no effect, (3) increase, and (4) decrease Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-73 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ACCOUNTING, ANALYSIS, AND PRINCIPLES ACCOUNTING January 15, 2010 Retained Earnings ($1.05 X 60,000) Cash 63,000 63,000 April 15, 2010 Retained Earnings [(10% X 60,000) X $14] Share Capital—Ordinary Share Premium—Ordinary 84,000 60,000 24,000 May 15, 2010 Treasury Shares (2,000 X $15) Cash 30,000 30,000 November 15, 2010 Cash ($18 X 1,000) Share Premium—Treasury Treasury Shares 18,000 3,000 15,000 December 31, 2010 Income Summary Retained Earnings 15-74 Copyright © 2011 John Wiley & Sons, Inc 370,000 370,000 Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) The balances are indicated in the following partial statement of financial position: AGASSI CORPORATION Statement of Financial Position (partial) December 31, 2010 Equity Share capital—ordinary, $10 par value, 66,000 shares issued and outstanding(1) Share premium—ordinary(2) Retained earnings(3) Treasury shares(4) Total equity (1) (2) (3) (4) $ 660,000 527,000 843,000 (15,000) $2,015,000 $600,000 + $60,000 $500,000 + $24,000 + $3,000 $620,000 – $63,000 – $84,000 + $370,000 $30,000 – $15,000 ANALYSIS Payout ratio: $63,000 ÷ $370,000 = 17% Return on ordinary share equity: $370,000 ÷ [($1,720,000 + $2,105,000) ÷ 2] = 19.3% PRINCIPLES Treasury shares sold above or below cost not result in gains or losses because treasury shares not meet the definition of an asset Rather, they are unissued equity Furthermore, gains or losses should not be recorded, because share repurchases and reissues are transactions with its own shareholders; the effects of such transactions should not be recorded in income Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-75 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROFESSIONAL RESEARCH (1) IAS addresses disclosure of information about capital structure (2) An entity shall disclose the following, either in the statement of financial position or the statement of changes in equity, or in the notes: (a) for each class of share capital: (i) the number of shares authorised; (ii) the number of shares issued and fully paid, and issued but not fully paid; (iii) par value per share, or that the shares have no par value; (iv) a reconciliation of the number of shares outstanding at the beginning and at the end of the period; (v) the rights, preferences and restrictions attaching to that class including restrictions on the distribution of dividends and the repayment of capital; (vi) shares in the entity held by the entity or by its subsidiaries or associates; and (vii) shares reserved for issue under options and contracts for the sale of shares, including terms and amounts; and (b) a description of the nature and purpose of each reserve within equity (para 79) An entity shall present, either in the statement of changes in equity or in the notes, the amount of dividends recognised as distributions to owners during the period, and the related amount per share (para 107) In paragraph 106, the components of equity include, for example, each class of contributed equity, the accumulated balance of each class of other comprehensive income and retained earnings (para 108) 15-76 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate: IFRS Edition, Solutions Manual To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROFESSIONAL RESEARCH (Continued) Changes in an entity’s equity between the beginning and the end of the reporting period reflect the increase or decrease in its net assets during the period Except for changes resulting from transactions with owners in their capacity as owners (such as equity contributions, reacquisitions of the entity’s own equity instruments and dividends) and transaction costs directly related to such transactions, the overall change in equity during a period represents the total amount of income and expense, including gains and losses, generated by the entity’s activities during that period (para 109) IAS requires retrospective adjustments to effect changes in accounting policies, to the extent practicable, except when the transition provisions in another IFRS require otherwise IAS also requires restatements to correct errors to be made retrospectively, to the extent practicable Retrospective adjustments and retrospective restatements are not changes in equity but they are adjustments to the opening balance of retained earnings, except when an IFRS requires retrospective adjustment of another component of equity Paragraph 106(b) requires disclosure in the statement of changes in equity of the total adjustment to each component of equity resulting from changes in accounting policies and, separately, from corrections of errors These adjustments are disclosed for each prior period and the beginning of the period Copyright © 2011 John Wiley & Sons, Inc Kieso Intermediate: IFRS Edition, Solutions Manual 15-77 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com PROFESSIONAL SIMULATION EXPLANATION (a) Common stock ordinary shares represents an owner’s claim against a portion of the total assets of the corporation As a result, it is a residual interest It therefore is part of equity (b) Treasury shares are not an asset When treasury shares are purchased, a reduction occurs in both assets (cash) and equity It is inappropriate to imply that a corporation can own part of itself Treasury shares may be sold to obtain funds, but that possibility does not make it an asset When a corporation buys back some of its own outstanding shares, it has reduced its capitalization, but it has not acquired an asset (c) ―Accumulated other comprehensive loss‖ is the sum of all previous ―other comprehensive income and loss‖ amounts A number of items may be included in the accumulated other comprehensive loss Among these items are foreign currency translation adjustments, unrealized holding gains and losses for non-trading equity investments and others (d) The accumulated deficit is larger in the current year because AMR, like many other major airlines, reported a net loss of $761 million AMR did not pay dividends in the current year, which would reduce retained earnings ANALYSIS $(581) ÷ 161.156* = $(3.61) *(182,350,259 – 21,194,312 treasury shares) Thus, AMR’s net worth is negative due to Treasury Shares and Accumulated Losses 15-78 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate: IFRS Edition, Solutions Manual ... Difficulty Time (minutes) E15 -1 E15-2 E15-3 E15-4 E15-5 E15-6 E15-7 E15-8 E15-9 E15 -10 E15 -11 E15 -12 E15 -13 E15 -14 E15 -15 E15 -16 E15 -17 E15 -18 E15 -19 E15-20 *E15- 21 *E15-22 *E15-23 *E15-24 Recording the... Moderate 15 –20 15 –20 10 15 20–25 10 15 25–30 15 –20 15 –20 15 –20 20–25 15 –20 10 15 10 15 10 12 10 15 05 10 20–25 30–35 20–25 15 –20 10 15 15 –20 15 –20 10 –20 P15 -1 P15-2 P15-3 P15-4 P15-5 P15-6 P15-7 P15-8... 11 , 12 11 , 12 , 15 , 16 , 18 3, 6, 7, 8, 9, 11 , 12 Explain the accounting for small and large share dividends, and for share splits 13 , 14 11 , 13 , 14 , 15 , 16 , 18 3, 8, 10 , 11 , 12 Indicate how to